Brokerages have changed significantly over the past 20 years. Aspiring traders with small accounts now can participate with much smaller accounts than in the past.

When first thinking about trading, most if not all traders start with stocks. However, the cost of buying shares to trade can quickly use all of the cash in a small account. I consider a small trading account as one of $5000 or less. There are a vast number of interested traders with accounts of $500 or less.

These traders quickly find out that they have to trade leveraged assets to have an ability to trade at all. This pushes them into assets like futures, forex, and options. You can learn to use options with a small account and limit risk in trades.

Many changes have taken place that has made trading options less costly, including free. There are now ways to limit risk that make it very easy to start trading with accounts of less than $1000.

These are a few of the most significant changes that have helped change the playing field for the retail investor.

Commissions

In the past, the typical brokerage would charge an options trader a ticket charge (minimum) per trade PLUS a fee per options contract. While this is still a widespread practice, most if not all brokers offer commissions based on a per option charge only. If you are paying a ticket charge, you should call your broker immediately and change to per option only.

Paying over $1 per option is too high.

Tastyworks offers a commission structure where you only pay to put on a trade and not to close it out, which can save you even more money over time.

Robinhood is an online broker offering no commissions to trade. Their trading platform is terrible. You need to spend some time learning it, but you can trade and not pay any commissions to do so.

As of this writing, I opened an account and funded it with $100 and am making trades. The bottom line is that commissions should no longer be a hurdle in getting started trading since there is no cost to overcome if you use a broker like Robinhood.

Strike Widths

One of the basic strategies options traders learn and begin with is credit spreads. These are high probability trades that are out of the money.

When I first started trading spreads, the strikes were 5 points apart. This meant that I would need $500 per trade minus my credit to trade one spread. Even in a $5000 account, you can't trade many of these every month as each trade would take up 10% of the account value.

Today there are many stocks with strike widths of 2.50, 1.00, and even .50. The margin needed for an options spread with 0.50 strike separation is $50 minus the credit you received. You can see how this would make trading and risk much easier when you are going into a trade with $50 vs. $500. It is a huge advantage for traders today.

Weekly Options

When I started trading back around 2000, I could only trade options that expired every 30 days. This limited the amount of turnover or trades I could make. You can open and close trades within that period as much as you want, but it does limit the choices you have.

Today, a large percentage of stocks and indexes have weekly options that provide more bang for the buck in the shorter expirations due to how Theta decays. If you don’t like one option contract that is expiring soon, you can look to the next weekly out in time or the next. The choices are much bigger today providing opportunities that just didn’t exist with only monthly expirations.

Putting is all together – A comparison of two spreads

The old: Commission of $6.95 per trade plus $1.50 per option.

5 dollar WIDE SPREAD WOULD COST $13.90 + $6 = $19.90 to enter and exit a trade plus $500 of margin. The cost alone is 4% of the margin that would have to be over come by profits. The new: Zero Commissions

One typically overlooked advantage of small width spreads is that the ROI tends to be better the smaller the width is versus trading wider spreads. This isn’t always the case but typically holds true and is worth investigating.

Calls and Puts are exchange-traded option contracts that were originally designed to act as insurance mechanisms to protect financial positions. These options are contracts between a buyer and seller that give the buyer a right and the seller an obligation to buy or sell a security at a specific price (the strike price) on or before the option’s expiration date. Each option contract represents 100 shares of the underlying security.

Here is a quick summary for buyers and sellers of calls and puts:

The Call buyer

Wants the underlying security to go UP

Has the RIGHT to exercise the option of BUYING the security at the strike price

The Call seller

Wants the underlying security to go DOWN

Has the OBLIGATION to SELL the security at the strike price IF THE OPTION IS EXERCISED BEFORE IT EXPIRES.

The Put buyer

Wants the underlying security to go DOWN

Has the RIGHT to exercise the option of SELLING the security at the strike price

The Put seller

Wants the underlying security to go UP

Has the OBLIGATION to BUY the security at the strike price IF THE OPTION IS EXERCISED BEFORE IT EXPIRES

Discussion and Examples

Call Options

XYZ stock is trading at $100 per share

XYZ stock DEC 100 calls are priced at $5.00.This means the XYZ stock call option has a $100 strike price, expires in December and is trading at $5

The call buyer will pay the call seller $5.00 times 100 shares = $500 for the RIGHT to purchase XYZ stock at $100 before the December expiration date. If XYZ rises above $105, the call buyer will make money as they can “exercise” the option to purchase XYZ at $100, and sell XYZ in the market at a higher price. The call buyer loses the $5.00 paid for the option so his “break even” price is $105.00

The call seller has the OBLIGATION to deliver XYZ stock to the call buyer anytime before the December expiration at $100 per share. If XYZ stock is trading below $100 per share on the expiration date, the call “expires worthless” and the call seller keeps the $5.00 he sold the call for. If XYZ price is over $100 per share, it will be “called away” and the call seller will have a loss as he will have to provide the call buyer XYZ stock and only receive $100 per share for it. Breakeven price for the call seller is also $105. If XYZ expires at $105, the call seller has to provide the stock to the call buyer at $100 per share and purchases the same 100 shares in the market at $105, but he can keep the original $5 received for selling the call option.

Put Options

XYZ stock is trading at $100 per share

XYZ stock DEC 100 puts are priced at $5.00.This means the XYZ stock put option has a $100 strike price, expires in December and is trading at $5

The put buyer will pay the put seller $5.00 times 100 shares = $500 for the RIGHT to sell XYZ stock at $100 before the December expiration date. If XYZ falls below $95, the put buyer will make money as they can “exercise” the option to sell XYZ at $100, and buy XYZ in the market at a lower price. The put buyer loses the $5.00 paid for the option so his “break even” price is $95.00

The put seller has the OBLIGATION to sell XYZ stock to the put buyer anytime before the December expiration at $100 per share. If XYZ stock is trading above $100 per share on the expiration date, the put “expires worthless” and the put seller keeps the $5.00 he sold the put for. If XYZ price is below $100 per share, it will be “put to the put seller” and the put seller will have a loss as he will have to sell XYZ stock to the put buyer and have to pay $100 per share for it. Breakeven price for the put seller is also $95. If XYZ expires at $95, the put seller has to purchase the stock from the put buyer at $100 per share and sell the same 100 shares in the market at $95, but he can keep the original $5 received for selling the put option.

Time Decay

Options lose value as they get closer to expiring. This time decay, or THETA, accelerates in the final thirty days of the option contract’s life.

Underlying Security Price Movement

If a security has a fast move in the correct direction the option buyer will have the advantage.

If the price movement is UP, call buyers benefit.

If the price movement is DOWN, put buyers benefit.

If a security moves slowly or trades in a range, the option seller has the advantage.

Options with strike prices closest to the current underlying security price change in value the fastest. If you do expect a security to move, avoid options far “out of the money”, or far above the current price for calls or far below the current security price for puts.

CAUTION

Options are leveraged and can expose you to significant risk. Sellers of calls have unlimited risk if the security price moves up. Sellers of puts have nearly unlimited risk if the security price moves down. Always strive to limit your risk either through the strategy or using conditional orders at your broker. Conditional orders may not help if the underlying security gaps up or gaps down in price. It is often best to establish limited risk option positions as an option seller using combinations of options trades, or spreads, to limit your risk. This avoids the price gap risk of the underlying security.

I hope this answers your basic questions about calls and puts. I’ll be adding more articles expanding how to use calls and puts together in spreads and in combination with the underlying security.

Dr. Daniel Lyons is a long-time friend and the creator of ExperCharts software, which I'll be using to generate signals for the ExperSignal trade alert service.

Daniel has PhDs in Cosmology and Applied Mathematics. His hand print algorithms he created many years ago have been applied to the financial markets. Daniel trades the FOREX market using 10-minute bars. He is giving me a longer time frame version that is more suitable for options trading.

Daniel limits the degrees of freedom to maintain reliability and consistency over time. ExperCharts has over 350,000 lines of C++ code already.

As you can see from the charts above, the software is very unique. The Neural Candles remove noise, which makes trend detection simple.

There are hundreds of millions of calculations every second that Daniel distills into charts, indicators and his engines. The result is a simplified view of the market in question with sophisticated tools to aid in determining if the market is turning or not.

The Trade Alert Service

Like many new things, unforeseen delays have pushed the launch of ExperSignal back. Daniel keeps getting closer to sending a fully debugged version to me so I can start the ExperSignal trade alert service.

THIS HAS NEVER BEEN TRADED BEFORE. HYPOTHETICAL PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS

The initial testing I did was VERY encouraging.

With a four-month backtest using a simple futures-only trading strategy, the test generated over $11,000 of profit using about $12,000 of margin. The biggest drawdown was -$750 with one of the two losing trades.

Daniel is including a spreadsheet with the price data and indicator values over time so I can refine what trading strategies to offer in the trade alert service.

I anticipate have several flavors of trades available:

Futures-only

Shorter-term options strategies

Longer-term options strategies

I don't have a launch date yet, as I'm waiting for Daniel to finalize the current version. It is getting much closer each day.

NOTE: After this version is sent to me, Daniel and I are going to discuss adding ES futures to ExperCharts. The software can handle it but Daniel doesn't have data for it as he only trades FOREX. The intention is definitely to add ES to ExperCharts so I can do futures and futures options strategies on ES, which has much more liquidity than the FOREX currency futures and futures options.

Ophir Gottlieb, CEO of Capital Market Laboratories, is speaking next week about their TradeMachine.

I looked at the TradeMachine several years ago while it was relatively new. In the past several years, it has matured into a very powerful back trading and alerting system.

So powerful in fact that banks and hedge funds now use it.

Who is Ophir Gottlieb?

Ophir Gottlieb is a former options market maker on the NYSE ARCA and CBOE exchange floors and a former Hedge Fund manager. He was recently invited to speak at the CFA Institute's annual conference in the United Kingdom about AI and his practical application to finding alpha.

Ophir is coming to Aeromir on Thursday 18 July 2019 at 11:00am Eastern to show us his TradeMachine and how he uses it.

What is the CMLViz TradeMachine?

If you haven't heard of the CMLViz TradeMachine, Ophir had two demonstrations recently. One is nearly two hours long and was very comprehensive. The second was an eight-minute quick walkthrough. Here are links to those demonstrations:

The CMLViz TradeMachine identifies patterns that have persisted for as much as 15-years, including through the Great Recession, and applies those patterns to option trading.

Here is an example of a simple covered call strategy. I used the S&P 500 as the universe of stocks to search and sorted the results by the total Backtest return. The test was the last three-years and selling a 30 Delta call, 30-days before options expiration.

The grey line on the chart below is the S&P 500 hypthetical baseline returns.

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

These results were generating in 10-15 seconds! Try doing that in OptionVue or OptionNET Explorer!

Ready to Get the TradeMachine Now?

Once you lock in your subscription price, you will keep that rate as long as you maintain your subscription. Ophir said he intends on raising the price next year to possibly $499/month. Now is a great time to get your subscription started.

Summary

The CMLViz TradeMachine is agreat investment research tool. You can quickly find candidates to manually backtest. Once you find your preferred strategies and symbols, you can set up alerts to be notified when your backtested trade setups have fired trading signals.

A diagonal spread may be a strategy you would like to implement into your trading arsenal. Today we will discuss how a diagonal spread is created. We will also reveal some of the advantages and disadvantages of a diagonal spread.

A diagonal spread is a strategy
which occurs when two options are bought or sold. These two options use the
same instrument. These two options are of the same type, either two calls or
two puts. The two options are at different strike prices, as well as two
different cycles of expiration.

When a long diagonal spread is
initiated, it can either be a net debit or a net credit to your account. A long
diagonal spread consists of an option which you buy with more days to expiration
than the option which you sell with less days to expiration. The strikes which
are bought or sold to create the diagonal spread will determine if the spread
is a debit or credit.

An Example of a Bullish Diagonal
Spread

A bullish diagonal spread can be
composed by buying an in-the-money call option far out in time. Then, you would
sell an additional call option with a dissimilar strike price which is usually
a little out-of-the money, along with a closer expiration date.

Below is a risk graph of an example of a Call Diagonal
Spread on SPY. This position has a
bullish bias.

Figure A. SPY Call
Diagonal Spread from Think or Swim

The setup for the bullish diagonal in Figure A is as
follows:

Purchase an in-the-money call, 376 days to expiration. The call purchased is the June 19 2020 280 strike.

Sell a slightly out-of-the-money call, 45 days to expiration. The short call is the July 19 2019 289 strike.

If you are able to keep an eye on your trade more often, you could explore selling shorter term options which could result in more opportunities to sell multiple cycles using the same long option. Of course, you do have more gamma risk with weekly options. Each cycle that you sell and are able to accrue a profit will lower the cost basis of the long call purchased.

How a Bearish Diagonal Could Be
Constructed …

Now let's look at the setup for a
bearish diagonal. Figure B below is an
example using SPY.

Figure B. SPY Put Diagonal Spread from Think or Swim

The example shown in Figure B above is a setup for a bearish diagonal spread; meaning you think SPY will move down. The setup for this diagonal is as follows:

Purchase a long term in-the-money put, 376 days to expiration. The put purchased is the June 19 2020 295 strike.

Sell a slightly out-of-the-money put. The short put is the July 19 2019 284 put.

The diagonal can also be used in a
similar manner as a covered call.

A covered call can tie up a lot of capital, because you have to purchase at least one hundred shares of stock to create the basis for a covered call.

A diagonal can help to diminish these capital requirements.

For example, a diagonal spread
could be created by buying an in-the-money call option 12 months or more in the
future. This call option would immediately have intrinsic value due to it being
in the money.

Using the above SPY example in
Figure A, SPY is trading at $288. The
call purchased in this example is the Jun 19 2020 280 call, which has $8.00 of
intrinsic value because it is in-the-money by $8.00. The long option would be a type of stock
substitute, as compared to purchasing 100 shares of stock which would be
required for a covered call.

Due to buying the option further
out in time, which in this case is 12.5 months, there will be some time premium
added to the price of the option. Most of this options' premium or cost will be
the intrinsic value and the rest will be time value.

Using this same example, the $280
SPY option strike cost was $22.82 and $8.00 of the premium for the option is
the intrinsic value. The other $14.82 of the premium, or cost of the option is
the time value of the option.

What is the maximum profit potential of
a diagonal spread?

The exact maximum profit
potential in a diagonal spread can't really be calculated because of the
position is using two expiration cycles.
However, to give you an idea as you analyze a potential position the
profit potential can be estimated with this formula:

For a bullish call diagonal spread, the width of
the call strikes, less the net debit paid, is the approximate maximum profit.

For a bearish diagonal spread using puts, the
same formula applies … the width of the
put strikes less the debit paid equals the approximate profit.

What is the breakeven of diagonal spreads?

Once again, the exact breakeven cannot be calculated because of the different expiration cycles of the options in the spread. To give you an idea, however:

For a bullish call diagonal, the approximate breakeven can be calculated by taking the price paid for the long call, plus the net debit paid.

For a bearish diagonal spread using puts, the same formula applies … take the price paid for the long put, minus the net debit paid.

Some Key Facts about Diagonal Spreads
…

Many traders use diagonal spreads as directional strategies. In this instance, your goal when entering the trade is for the price of the instrument to trade to the short strike option you sold, but not to go beyond the short strike. If the price of the instrument crosses above the short strike of the option you sold, you may want to roll the option out in time and out in price. Or, you could close the short option position before expiration day, if the option has gone in the money. Keep in mind, however, if you choose the keep the position open and the short has gone in-the-money, you run the risk of assignment.

3-6 Emails per day discussing Scott's views on the current market and how he is planning to trade it

50 Weekly education webinars (ever Wed) per year

Scott's paper money account is up about +90% for the year already and we're not even to the mid-point.

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS

Scott and I wanted to offer Scott's trades at a lower price point so Scott created Mini-POT, which is nearly identical to the full POT class but with only one educational webinar per month plus an added Live Q&A webinar per month.

The trades are the same. The emails are the same.

Mini-POT subscribers won't have the same level of personal help from Scott but it's half the price of the full POT class.

Scott showed his background, his trading philosophy and ran through an example trade before answering questions about Mini-POT. Watch the replay here:

Click the button below to join the new Mini-POT trial, which is planned to last one month.

Scott Ruble (aka J.L. Lord pen name) from StratagemTrade.com is a successful former CBOE market maker who has been teaching Practical Options Tactics (P.O.T.) for many years. Scott's POT trades are already +91% in 2019.

Scott has agreed to run a miniature version of his flagship product at Aeromir.com. Mini-POT Trades will be the service at Aeromir.com

What's the difference between POT and Mini-POT?

The two are very similar but Mini-POT is more limited in scope. Mini-POT has:

The same trades Scott sends out to POT only in an abbreviated format.

Access to the POT trade tracking spreadsheet with details of each leg in every trade.

A monthly Q&A webinar to ask Scott questions

One of the four POT classes Scott teaches each month

Scott's emails he sends to POT subscribers. This is normally 3-6 emails per day describing Scott's thinking of what the markets are doing and his plans of why he's making each trade

Mini-POT does NOT have:

All of the live classes Scott teaches every week.

Less personal interaction.

What does a typical trade look like?

This is a recent POT trade. The red is the area you can lose money and the green is the area you make a profit.

Scott's trades seek to minimize risk while still leaving good profit potential as you can see above.

Scott is presenting his new Mini-POT Trades on Friday at 11:00am Eastern.

First, a little about risk …

Every trader is intimately acquainted with risk. Trading both stocks and options has large
potential for rewards, but also risks.
In order to sustain a successful trading career, a trader must be
willing to accept risk. The basic rule of thumb I was taught many years ago
when I first started trading was “never trade with money you can't afford
to lose.” There are no guarantees
in trading that any position will yield a perfect reward. As a trader, you
settle for the probabilities and potentials, and manage risk accordingly. Having said that, however, by predefining the
risk you can afford to sustain, you can avoid making mistakes that jeopardize
your entire trading account, and career.

Most traders are always trying to locate new strategies that
offer healthy rewards with minimal risk.
It is only with trading experience that you are able to easily assess
the risk of a particular strategy and use it to your advantage. But, the basic rule of thumb remains the key
to successful trading: Never take on the
risk unless it's worth the return.

What are the two types of risks?

Basically, there are two types of risks – the known and the
unkown. Each time you place a trade, you are putting the risk of that trade on
the line. This is a known risk, because
it involves a specific amount of money.
The unknown risk that is lurking in the market can take on many
forms. Everything from economic or
political news, earnings, and natural disasters can have some effect on the
market, creating this unknown risk.

Risk is not viewed the same by every
trader…

One trader's perspective of risk may be viewed as irrational
thinking by another. Risk is relative,
but to the person who perceives it in a given moment, it is absolute and beyond
question in his/her mind.

Understanding and accepting risk is
the most important aspect of trading

There isn't any element of trading that is more important
than having a true understanding of risk; how to accept it and how to manage
it. Accepting risk means that you are
able to accept the outcome of your trades without emotional despair or
fear. It doesn't do any good to take on
the risk of entering a trade if you fear the consequences; doing so means that
you have not taken on the full understanding of risk.

The more successful traders not only take on the risk
without any trepidation or fear, but experience has taught them to actually
embrace that risk.

“When you genuinely accept the risks, you will be at peace with
any outcome”. Mark Douglas

Having a complete understanding and the willingness to accept risk does not happen overnight; it evolves over time as you fine-tune your trading skills. It all starts as you develop your trading plan and identifying those strategies and associated risk level that work in conjunction with your account size, and trading style. The full understanding and acceptance of risk does not come immediately to a new trader; it is developed over time with experience back testing, paper trading, and trading live starting with small positions. As you learn to identify the risk associated with each and every trade, you will be more prepared to accept the inherent risk that goes along with trading, and eventually embrace that risk.

Now, let's talk about Risk/Reward
Ratio and what it means in trading …

Risk/ratio is widely used by traders and financial
professionals all over the world when analyzing a trade or investment. Basically, risk/reward measures the amount of
reward expected for every dollar at risk.
The risk/reward with complex options strategies can be useful to analyze
positions to determine the relationship between the risk and reward.

Here is a very simple example of how
risk/reward is calculated …

Let's say a friend asked you to lend him $25. In return for your agreeing to the loan, your
friend agrees to pay you back $50 in two months. The reward (payback amount of $50), divided
by your risk (amount of the loan of $25) equals the risk/reward ratio. In this scenario, you would have a 2:1
risk/reward ratio. You are risking $25
for a potential reward of $50.

Why is it important for options
traders to calculate the risk/reward ratio?

Calculating the risk/reward ratio before entering a new
position is an exercise most professional options traders perform on a regular
basis. This habit can help you make a
better decision in your trading.
Sometimes, it may be surprising to see that the risk/reward ratio of
some strategies that you feel are a “win/win” strategy are actually
quite unfavorable when the math is worked out.
Calculating the risk/reward ratio before entering a position can help
avoid potentially unprofitable trades that are not immediately obvious. Many traders can also make it their own
personal policy to only trade positions where a certain risk/reward is
met. Some traders have as high a
risk/reward ratio of 4:1 as their “threshold”, although a ratio of
2:1 is commonly used by retail traders as this ratio “theoretically”
gives the trader the potential to double their money.

Let's look at some examples of a few options trades and the
risk/reward ratio associated with each of them.

Bullish
Call Spread on XYZ Company

XYZ is currently trading at $12, and you have a bullish
bias. You purchase a call debit spread,
+10 strike/-$15 strike at a cost of $1.50.
The maximum profit of the spread is $3.50 ($5, which is the width of the
spread, minus the cost of $1.50). If XYZ
closes at $15 above expiration, the full profit can be realized of $350 (less
commissions).

You enter a 10-point wide Iron Condor on ABC Company and
receive a credit of $1.25. The maximum
potential profit of the trade is $1.25 (credit received), as long as ABC
Company remains within the two short strikes.
Your total risk is $875 ($1,000 for the 10-point wide wings, less your
credit of $1.25).

In this second example, this type of risk/reward ratio is
considered by many traders to be unacceptable; where you are risking $875 to
potentially only make $1.25.

Summing it up …

Many options trades look and sound good at first
glance. Sometimes, inexperienced traders
may fall into the trap of not achieving their anticipated returns after
entering a position even though the underlying is performing as they
expected. The reason for this may be
that they did not understand the true risk/reward at trade entry. Traders who have a full understanding of
their risk, and the risk/reward of every trade before entering it can make a
more informed, intelligent decision on which strategy to implement in order to
maximize their profit potential.

If you are looking for a trading group where traders of all
experience levels share their trades and give excellent feedback, look no more.

I hope this article serves as a refresher on risk and
risk/reward. If you have would like to
add anything you have personally found helpful in your trading regarding risk, feel free to
comment below.